Eye On Two Americas...

Toxic levels of consumer confidence on Main Street remain. This is happening despite Wall Street's call to arms that we should "drill, drill, drill", bring down oil prices, and solve all problems inflation related in one fell swoop.

The US$ has recovered alongside the US stock market this month. Gas pump prices have fallen alongside oil's decline. But every week the ABC/Washington Post Consumer Confidence reading shows no dice. No change.

At a -50 weekly reading, all time lows remain reality in Main Street confidence. Two Americas remain as a result. Get used to Obama's attack dog Democrats reminding Wall Street of the same.

Spain's Stagflation

Below is a chart putting a picture to Spain's ominous economic situation. This week Spain reported producer price inflation at a 24 year high of +10.2% year over year. As the Euro currency depreciates, European countries have an accelerating feature in imported inflation.

Why do global macro investors care about Spain's GDP? Well, for starters, it's still the 8th largest economy in the world. It's also one of the country's who levered up their balance sheet aggressively to the asset leverage cycle.

Stay tuned...

(chart by Andrew Barber, Director, Research Edge LLC)

JCG: Where Have We Seen This Story Before?

History is repeating itself. Retailers that don’t respect the impact of macro trends in planning their businesses are destined for mediocrity – at best.

Here’s a lesson about what not to do in retail. 1) Get over confident in your brand and market positioning. 2) Allocate capital accordingly – including on expensive real estate. 3) Ignore the macro headwinds coming and the change in behavior likely to be seen as competitors get increasingly desperate. 4) When comp plans start to miss, jam more product into the stores to drive revenue.

This, unfortunately, is J Crew. It was Gap as well (both Mickey Drexler). Not to unfairly single him out – this has been the case for many a retailer that doesn’t do macro analysis in planning their respective businesses.

Where does this leave JCG now? In a bad bad spot. Take the quarter, for example. Comps were flattish, and 10% revenue growth was almost entirely driven by square footage. Revenue is trending down steadily on a 1, 2 and 3-year run rate. Gross margins, however, took a sharp dog leg down – the greatest since 2004. When this happens, we should expect inventories to end clean, right? Not with JCG. Even with margins down meaningfully, inventory was up 25% at quarter end.

This is when our sales/inventory/margin map tells a frightening story. Check it out below. One might think that any move from where it is today is a positive one (i.e., things can only get better, right?). Not true. It is possible for JCG to own that lower left quadrant for several more quarters to come. Management’s current guidance does not suggest that this is the plan.
This is the worst place for JCG to be. History shows us that a position in this quadrant is usually not only a 1quarter rental.

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The 3 Months That Changed The "Fast Money" Game: What's Next?

Below is a chart that shows the US Dollar/Euro "Trade" that global markets have endured for the last 3 months. THE Question is, does this morph into an intermediate "Trend", or was this simply a short term “Trade” that will revert back to its long term mean?

The US Dollar Index looks like it runs out of runway at the 77.80 level. Commodity prices are moving into positive buy signal territory using very short duration momentum models, ostensibly as a leading indicator of a “Trade” down in the US$.

If Bernanke keeps the easy money card on the table. I don't see why one last hurrah for the commodity bulls can't happen.


Bear Hunting

Our senior research sector heads are increasingly convinced that genuine bottoms up Research Edge lies in asking “The Question” – who is first to step away from the Street’s pervasive groupthink? Who asks THE critical question first? My macro question at our morning meeting on Monday was “who is more afraid right now, the Bears, or the Bulls”?

Alpha is generated if you ask the best questions first. Importantly, you can shorten the duration in maximizing that holy grail of alpha the faster you find conviction in THE answers to those questions. My answer to the aforementioned question is that today is much like May, the Bears are NOT Bearish Enough.

Anyone who has studied bears (or lived in Northern Ontario with them in your back yard) knows that they have very short attention spans. As a species, they are very comparable to “momentum” oriented hedge fund traders. Bears can hear things from distances as far as a mile away. They have as Wikipedia appropriately points out, “elusiveness and sharp senses”. Humans are generally as scared of them as bears are from themselves. This is exactly how I feel about the US and Global Stock markets right now. No one trusts anyone and, on up days, the bears are faster covering than the bulls are buying. All the while, save the survival of the fittest, funds managed for weekly and monthly returns are being hunted down, and shot.

Other than using guns, across the ages there have been many other ways that we have hunted bear – knifing, snaring, calling - not all of these strategies are incredibly effective, particularly when everyone is running around yelling at each other. Predictably, as we are seeing in today’s market, politicians have always offered up some ingenious tactics. The most famous might be Teddy Roosevelt’s book titled “Hunting the Grisly”, where Wikipedia again notes that Teddy thought “small terriers could be used against bears, they usually only worked against bears which had never had the experience of being hunted before…the terriers would irritate and distract the bear with their yapping.” Sound familiar?

As of last night, the Democrats official released their US market hounds. Everyone from the self proclaimed savior of “the sister hood of the pantsuit” to the Governor of Montana took to the stage and started barking back at the McCain Bulls. Barrack Obama is a lot of things, but one of them is not stupid. It’s “Macro Time” - get used to his orchestrating this daily market distraction. As an old Chinese proverb goes, ‘one dog barks because it sees something; a hundred dogs bark because they heard the first dog bark.”

Of course, away from trying to figure out whether the Bulls or Bears are more right, the global marketplace will be issued economic and geopolitical facts, daily. Facts are stubborn little critters that can be hidden from the market, until they can no longer be ignored. Last night the Federal Deposit Insurance Corporation (FDIC), which was created during this country’s last economic depression in 1933, sprayed some bear mace in the bull’s eyes, reminding them that we are still in the early stages of the US bankruptcy cycle. Head of the FDIC, Sheila Bair, stated “Quite frankly, the results were pretty dismal, and we don't see a return to the high earnings levels of previous years any time soon.” Good thing she is being “frank”!

There is a front page article this morning in the Wall Street Journal that talks about the reality that US banks actually have debts that come due, and that they’ll need to refinance them at higher rates. Isn’t that a shocking revelation of factual data! Meanwhile Morgan Stanley’s head of foreign currency research is making a “call” that Asian currencies can go down a lot when economic growth slows. Eureka! They didn’t ask the question first, but they are finding the right answers!

I am smiling partly because I can’t believe I spent so much time this morning writing about animals. I am smiling partly, because the expiration date on the cream for my coffee this morning said August 30th – that’s when I get paid my hunters ration of interest income on my most concentrated position, 85% cash. I am smiling because we asked a lot of the right questions 9 months ago, and found conviction in the right answers.

Happy hunting,


This October will bring a very interesting dynamic to the slot machine industry. IGT will cease to install conversion kits on all of its platforms with the exception of the newest, AVP. This looks to me to be a pretty big bet on Server Based Gaming (SBG).

  • Sluggish replacement sales have masked a solid conversion environment over the past 2 years. As can be seen in the first chart, conversion activity has not followed the downward plunge in slot demand. For the casinos, conversions are a big time money saver. Slot boxes last for a long time, game appeal does not. Game conversions run in the $4-5k range versus $12k+ for a whole new slot machine. Obviously for the supplier, a full slot sale is preferable. I attribute the relative strength of conversion sales to the following:

    • Better technology
    • Operators converting ahead of IGT’s dictum (customers were notified over a year prior)
    • Casinos with cash-strapped balance sheets pursuing the lower cost conversion alternative
    • Shorter “game appeal” duration

  • The 2nd chart shows that IGT has a little over 500,000 of the 900,000 slots installed in North America. Only 30,000 of these machines are on the AVP platform, leaving a significant number of machines unconvertible. An IGT bull might say that due to competitive conditions between the operators, casinos will be forced to replace existing games with brand new machines. Alternatively, SBG provides an easy solution whereby new games can be purchased and downloaded automatically on the AVP platform. On the other hand, IGT’s conversion decision now puts almost 500k machines up for grabs. Casinos do not have to replace an IGT machine with an IGT machine. Where there’s a bull, there’s a bear.

  • That’s the IGT story. The BYI and WMS stories are altogether different. At the very least, I think IGT’s decision could spur more conversions for BYI and WMS. More likely, the move opens the door for more market share gains, at full pricing. Again, that’s almost a half of a million slot machines that will ultimately be replaced and not converted.

Slot conversion growth outpaced replacements. A lot of market share up for grabs.
IGT Bull vs Bear


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